Bosnia and Herzegovina Business Forecast Report Q2 2009

Significant Slowdown Ahead The Q209 Bosnia-Herzegovina Business Forecast Report paints a decidedly grim picture for Bosnia's macroeconomic and political stability. While we previously cautioned that the country would be unable to avoid knock-on effects of the regional economic downturn, the increasingly dim growth outlook for Bosnia's main trading partners has confirmed our view that 2009 will see a considerable slowdown in economic activity. Although the export-oriented manufacturing sector will surely be hit from a lack of external demand, we caution that an expected slowdown in asset and loan growth in the banking sector will weigh on domestic consumption. Combined with an expected drop-off in remittance inflows, we note that the main drivers of Bosnian growth will be significantly curtailed through the medium term, with real GDP growth forecast to come in at -0.5% in 2009. We are also concerned about what impact the economic slowdown will have on political stability. Given Bosnia's highly fractious political environment, and the tensions likely to emerge in the run-up to negotiations over constitutional amendments, we expect political risk to remain a key factor weighing on the country's medium-term stability.

We believe ongoing tensions among political leaders, in addition to an expected slowdown in economic activity and uncertainty over constitutional reform, necessitate a further downward revision to the country's short-term political risk rating. Following adjustments to the 'policy-formation', 'unemployment' and 'constitutional change' subcomponents of BMI's risk rating methodology, Bosnia's short-term political risk rating has fallen to 43.5 from 46.3 out of 100. According to this rating, the political environment in Sarajevo is the most unstable in the entire Western Balkan region, and likely to remain so through the medium term.

In light of the deteriorating macroeconomic outlook across the emerging Europe region, we believe Bosnia's fiscal dynamics are set to come under increasing pressure through the medium term.

Although Sarajevo has consistently posted budget surpluses since 2003, we expect 2009 to pose a significant test to the government's willingness and ability to pursue a balanced budget at a time of slowing economic growth and still-elevated demands for increased social spending. A reduction in government revenue streams will be the primary factor weighing on Bosnian finances, driven primarily through the reduction in export and tax revenues. We forecast revenues contracting by 0.2% year-on-year (y-o-y), which is well below the 11.4% y-o-y expansion expected between 2003 and 2008. In contrast, BMI forecasts government spending to remain relatively robust through the medium term, with expenditures forecast to grow by 3.9% y-o-y. We believe 2009 will see Bosnia posting its first fiscal budget deficit since 2002, which we expect to come in at -1.6% of GDP.

In a further indication of the problems afflicting the business environment in Bosnia-Herzegovina, the country was ranked 134th (out of 179 countries) according to the 2009 Index of Economic Freedom. A joint production between the The Heritage Foundation and the Wall Street Journal, the index measures and compares countries across 10 specific definitions of economic freedom.

Bosnia's business environment continues to be hampered by a complex legal and regulatory structure, owing primarily to multiple and sometimes overlapping levels of government. BMI's business environment rating for Bosnia is 41.5, the worst in the Western Balkan region.